Britain’s AAA credit rating threatened by scale of bank bail-out

Britain could be stripped of its prized AAA credit rating as a result of the Government’s latest bank bail-out, potentially jeopardising any economic recovery, according to rating agency Standard & Poor’s.

S&P only last month confirmed its “stable outlook” for the country’s sovereign debt but may now be forced to review the top-notch rating.

The change has been prompted by the Government’s asset protection scheme – insurance for toxic debt – which will leave the taxpayer exposed to losses on billions of pounds of bad loans made by the banks.

A downgrade would be calamitous for the country, which is on course to borrow an extra £500bn over five years, taking the national debt above £1 trillion for the first time. Should the UK lose its AAA rating or even be put on “negative watch”, the country’s interest bill would soar – putting further strain on the economy.

S&P indicated it might have to revisit the rating in evidence before the Treasury Select Committee last month. Under questioning, Barry Hancock, head of European corporate ratings, said S&P had confirmed the UK’s status on the assumption that “up to approximately 20pc of GDP in the form of bank assets could be problematic in the future”.

With annual economic output running at £1,400bn, 20pc would equate to £280bn. However, it has since emerged that the Treasury is preparing to ring-fence about £400bn of “toxic” bank debt – or 29pc of GDP – to draw a line under the financial crisis. Royal Bank of Scotland is said to want to use the scheme for £200bn alone.

A ratings downgrade or a shift to “negative watch” could be devastating for the Government’s planned economic stimulus package. As recently as last November, Frank Gill, S&P’s director of European sovereign ratings, raised concerns about the Government’s spending plans, warning that net debt above 60pc of GDP could undermine the AAA rating. Economists have forecast debt to reach 70pc of GDP by 2011.

S&P has already downgraded the sovereign ratings of Spain and Greece this year. Questioned about the UK, Mr Hancock told MPs: “We are looking at the ratings on an ongoing basis. If there were major shocks or changes we would look at the rating again.”

Credit default swaps (CDS) on UK sovereign debt, which act as insurance for borrowers, have risen sharply this year, from 106.9 to 158.6, indicating the market’s dwindling faith in the security of UK gilts. Tellingly, the UK has tracked Spain, where CDS have risen from 100.7 to 156.8 this year.

George Buckley, chief UK economist at Deutsche Bank, said: “While there is an increased risk of a downgrade it seems very unlikely the UK Government will ever default on its debt commitments.” S&P declined to comment further. The Treasury also declined to comment.